Five China companies to consider investing in

Commentary: Pros and cons of big Chinese companies

BOSTON (MarketWatch) — It used to be when E.F. Hutton spoke, we would listen. Now it’s PIMCO.

Yes, a world of investors seems to hang on every word spoken by Bill Gross or Mohamed A. El-Erian or just about any one of the many experts in the PIMCO stable. When PIMCO speaks, money moves and markets shift.

Case in point: Maria Gordon, who manages the newly launched PIMCO EqS Emerging Markets fund
PEQAX
just said she has a “favorable view of the yuan” and is now “large overweight” on China. And that pronouncement has more than a few investors (not to mention yours truly) thinking about the ways to play China. What’s good enough for PIMCO, should be good enough for the rest of us, yes?

Like Gordon, Philip Abbenhaus, the director of the Asian Equity Research Institute, is bullish on China, too. According to Abbenhaus, whose institute issues the China Business Conditions index, there are plenty of reasons for this opinion; China’s economy has grown 9.7% per year since 1978 and it’s now the second largest economy in the world; its 1.3 billion people are fast becoming consumers of goods and services; and its political environment is more stable in the wake of the recently concluded 2001 Central Government Economic Work Conference.

What’s more, the issuing of the first yuan-based real estate investment trust this week is promising as well, said Abbenhaus, whose institute gets its information on the Chinese market through Hexin Flush, a research firm based in Hangzhou, China. Read more about the yuan-based REIT.

To be sure, there are plenty of risks associated with investing in individual Chinese companies, according to Abbenhaus, whose institute is housed in Trulaske College of Business at the University of Missouri.

Information about Chinese A-share market trends, overall economic activity in China and significant government policy changes are not easy to come by. And that makes it harder for average investors to get a bead on what’s really going on in China, especially among the micro-, small- and mid-cap companies. (By way of background, the Chinese A-share market, as of 2010, was made up of more than 531 companies that could be owned and traded only by Chinese citizens. And there are about 250 Chinese companies listed on U.S. stocks exchanges.)

Plus, there was the issue of reverse merger IPOs or what some called reverse takeovers or RTOs that raised a red flag, according to Abbenhaus. And then there’s the fact that many still refer to China as an emerging market; there’s the prospect of inflation; there’s the growing presence of short-sellers; and the list goes on.

But Abbenhaus said none of those risks and red flags should dissuade average investors from considering, if nothing else, five of the largest Chinese companies. “For most average investors bigger is better,” said Abbenhaus in an interview.

China Life Insurance Co.
LFC, -0.95%
along with Ping An, and China Pacific Life are the largest insurance companies in China. But China Life, which claims having 770,000 exclusive agents, is the largest seller of life insurance and annuity products in China and its one of the leading sellers of group life insurance and annuity products.

Despite its market share, investing in China Life is not without its risks. For one, China Life is not able to fully mitigate its interest rate risk. Plus, nearly half of the company’s assets comprise debt securities. “Economic conditions, bankruptcies, lack of liquidity and other failures of the underlying debt investments could impair China Life’s financial condition,” Abbenhaus wrote in a recent report. (Last month, the company said it had no plans to replenish its capital even though its solvency ratio (a measure of its ability to meet long-term obligations) had dropped 219% at the end of 2010 from 300% a year earlier.)

Insurance laws and regulations in China limit the universe of securities available to the company for investment. And that limits the company’s investment return and its ability to diversify to reduce risk levels. There’s the possibility that increased competition from both domestic and foreign-invested life insurance companies could affects business and market share. And last there’s the potential impact of catastrophic events. China Life does not carry catastrophe reinsurance, which leaves the company at risk of being significantly impacted in the event of a catastrophe. And then there’s this: China’s audit office said earlier this year it uncovered “improper and illegal activities” involving about $458 million at two of the country’s largest insurers, People’s Insurance Co. (Group) of China Ltd. and China Life Insurance (Group) Co., during an audit of their 2009 books.

Another mega-cap is China Mobile Ltd.
CHL, -0.28%
which is the largest mobile telecommunications provider in the world, as measured by the number of customers served. The company has a 70% share of the mobile telephone market in China, but Abbenhaus noted in a recent report that investing China Mobile has risk factors as well. For one, current growth levels may not be sustainable. There’s increasing competition. Plus, China Mobile’s success depends on the evolution of technology and the company’s ability to keep up with changes. “Specifically, the company’s 3G network is based on TD-SCDMA technology, which may not be widely adopted and/or could be replaced with competing, more mature technologies,” Abbenhaus wrote. And there’s a changing regulatory environment that could create costs that could lead to decreased profitability if not balanced with other cost savings. And China Mobile’s allocated portion of the frequency spectrum could eventually limit the company’s growth if it cannot obtain more in the future.

China Petroleum and Chemical Corp., or Sinopec.
SNP, -0.99%
is the country’s largest producer of petroleum products and chemicals and should benefit in the long term from China’s booming economy. But as with China Mobile and China Life, there are plenty of risks to consider. According to Abbenhaus’ report, the Sinopec relies significantly on outside suppliers for additional crude oil and other feedstocks for its refined products; its business involves a number of operating hazards; it competes with major integrated petroleum and petrochemical companies domestically and internationally; and the oil industry in China is highly regulated and standards are constantly evolving, particularly regarding environmental protection. “Meeting these requirements may impose significant costs on the company, which could reduce profitability,” Abbenhaus wrote.

CNOOC Limited
CEO, -0.23%
which is trading closer to its 52-week high than its 52-week low, might not be undervalued at the moment, but with a $110 billion market capitalization it’s fits through Abbenhaus’ screen for mega-cap stocks. The company is China’s third-largest oil and gas company and it also has operations in Indonesia, Nigeria, and Australia.

Like the other Chinese companies, there are risks: A large amount of CNOOC Limited’s crude oil are sold to Sinopec and PetroChina refineries and given that the company does not have long-term contracts with these customers its financial condition would be significantly impacted through reduction in purchases by its customers. As noted with Sinopec, the oil and gas industries are highly competitive within China and the highly regulated. Plus, any natural disaster and the like that affects the company’s ability to complete exploration, development, and production activities will adversely impact the business.

And last but not least, there’s PetroChina Company Ltd.
PTR, -1.34%
which is China’s largest oil and gas company. Among the reasons why one might consider PetroChina are those just given by Zacks Investment Research. Zacks this week upgraded PetroChina to outperform from neutral, a reflection of its leverage to the fast-growing Chinese market and the turnaround in commodity prices. “Being one of only two Chinese integrated oil companies, PetroChina is well-positioned to capitalize on these favorable trends,” Zacks said.

Still there are risks, according to Abbenhaus. The company has relatively high transportation costs; it refineries and chemical plants are located in western and northern China whereas higher demand for products are in eastern and southern China, Abbenhaus wrote.

And as already noted with the Sinopec and CNOOC, there’s strong competition within the oil and gas industry, changes in regulatory environment could lead hamper profits, and the hazards of gas exploration, production, and transportation could have a financial impact on the company, as well.

For those not so fond of buying individual stocks, Abbenhaus suggested ETFs such as the iShares FTSE/Xinhua China 25 Index
FXI, -1.40%
PowerShares Golden Dragon Halter USX China Portfolio
PGJ, -0.54%
or the SPDR S&P China
GXC, -1.38%
and mutual funds such as the Templeton China World fund
TCWAX, -0.09%

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